Interview with Veteran CANSLIM Trader Steve Swetz
Detailed Analysis Of A Profitable CANSLIM Trading System
Here we get an in depth view of a profitable trading system making use of the CANSLIM methodology as Steve Swetz, a full-time CANSLIM trader walks us through his overall process with real trade examples, showing what is necessary to make the jump to profitability by developing a well-structured and sound trading system:
How did you originally get into trading?
I have always been interested in the stock market going back to my days in high school where I competed in a stock market contest using play money. I loved the game of being able to make money based completely on my own ability, and I love solving puzzles. I think the stock market is the ultimate puzzle. Like most anyone, I started out going to the bookstore and just thumbing through investment books that interested me.
Back in 1997, I stumbled upon Bill O’Neil’s book “How to Make Money in Stocks” and it really made sense to me. I started trading with a very small amount of money in November 1997 using CANSLIM when I bought my first stock Timberline Software (TMBS) at around $12/share and sold it in June 1998 for about $24/share. From that point on, I was hooked. I saw the power of CANSLIM.
What was the process of going from an unprofitable trader to a profitable one like?
Going from an unprofitable trader to a profitable trader was really a very slow process. I did not become consistently profitable until 6-7 years after I began trading. In fact, after making a lot of money during the internet bubble, I suffered a 75% drawdown. Needless to say, I was a pretty terrible trader and I knew it.
I went back to the drawing board. I would read about the importance of consistently applying a method with discipline and patience but I never really embraced it. I would trade with no set of rules, I would style drift, I failed to prepare to trade, I had no consistent routine, I failed to keep records, and I did no post-analysis. All of these faults of mine led to other problems like FOMO and impulsive trading. The stock market has a way of revealing all of my weaknesses.
I had two turning points:
Realizing that LESS is MORE.
In other words, I needed to keep my trading as SIMPLE as possible. My written buy and sell rules, my written stock selection process, my written chart reading process, and my written market analysis process ALL had to be SIMPLE consisting of only a FEW elements. For years, I thought that I had to know all about these “fancy” indicators to make money. Nothing could be further from the truth. In my experience, these indicators only created analysis paralysis and complicated the decision-making process for me.
After conducting post-analysis of my trades. I could see that my improved results were from consistently following a SIMPLE PROCESS with discipline and patience. I could see that I needed to focus on improving on simplifying my process. The good results would come automatically. Even though I was no longer losing money, I really was not making much money either which led to my 2nd turning point or maybe an “aha” moment:
In 2005, I attended a Level 2 IBD workshop in Hawaii. There were 3 takeaways from that workshop that dramatically improved my results.
First, insist on a very strong prior uptrend before a base builds.
Second, buy breakouts from TIGHT areas on the right hand side of the base. Buying any old breakout is not good enough.
Third, understand what drives the company’s sales and look for strong sales growth. Once I learned to focus on these 3 aspects, my stock selection greatly improved which led to my results greatly improving.
These 3 takeaways may be obvious to many of you but they were not to me. Even though all of Bill O’Neil’s books emphasized the importance of a strong prior uptrend and tightness, those concepts still did not sink into my head until I attended this workshop.
Was there a specific trade which really showed you that you are maturing as a trader?
The one specific trade I remember that really showed me that I was on the right path of becoming a good trader was when I bought TIE (Titanium Metals) in early 2006 and sold it a couple of months later for a 100% gain.
The gain was good but the process of picking a true market leader and then using my rules to buy, add, and then sell in a disciplined and patient manner really showed me that maybe I have a chance to become a full-time trader.
How do you understand the market environment we would be in?
I analyze the market environment using the 3 leg stool that IBD teaches. The 3 legs in order of importance are my holdings, the liquid leaders, and then the major indexes (Nasdaq and S&P 500).
I am aware of the trend of the interest rates, which we call the 4th leg, but it is the 3 legs that really tell me everything I need to know about the market environment. As far as I am concerned, nothing else matters and everything else only complicates the analysis where our misguided emotions can get the best of us.
How do you understand the market environment objectively and remove any emotion that may cloud your judgment?
In judging the stock market indexes, I look at the slope of the 40 week MA and 10 week MA and where the Nasdaq and S&P 500 indices are relative to those 2 simple moving averages. This analysis gives me my major trend view which we can all see is down currently. Within this major downtrend, I look for turning points to begin rallies. I call these turning points windows of opportunity (WOO).
The WOO is determined by using the IBD “follow-through day” and the relationship of the Nasdaq to its 21 day EMA and the slope of its 10 day simple moving average. The WOOs are more likely to fail or lead to only trade-able rallies when the major trend is down like we have seen this year. Knowing this characteristic and identifying very few potential true market leaders (TMLs), I know to do less trading and be quicker to take profits and losses. When the major trend is turning up in the indexes and I see potential TMLs triggering entries out of long bases, I am going to be slow to take profits. The most powerful WOOs which can lead to life-changing money occur either when the major indexes have a selling climax and potential liquid TMLs are setting up to buy or when the slopes of the 40 week MA of the major indexes, after having already been in a downtrend, begin to flatten out and potential liquid TMLs are setting up to buy.
Also, and more importantly, I am looking to see if any potential true market leaders (TMLs) are setting up. If I do not see any TMLs setting up, even if the WOO opens, I will not buy. I will sometimes buy a potential TML before the WOO opens because sometimes the very strongest TMLs will trigger an entry before a WOO opens. Remember, the more important leg of the 3 leg stool is the action of the liquid TMLs, not the major indexes.
How do you know when it is time to really press the gas and go for it vs understanding that it is better to wait in cash for future opportunities?
When my trades are working, I keep buying. If I have 4 full positions which are all profitable or maybe 5 out of 6 partial positions which are profitable, then I am willing to go on margin if I continue seeing true market leaders (TMLs) setting up. It is the quantity of potential TMLs and how well my stocks are performing which will determine how aggressively I increase my market exposure.
What is your criteria for a good setup and how do you manage each trade?
I look for stocks trading within 20-25% of all-time highs showing very high quarterly/annual EPS and sales growth and accelerating quarterly EPS/sales growth currently or in the recent past.
I want strong “new” factors which means a young company or new products/services or a new industry change or new management. I want the stock to be a leader in its industry group in terms of relative strength, return on equity, and profit margins.
I want to see a very strong prior uptrend with above average weekly volume before an early stage base builds. The base must give strong clues of institutional accumulation. I want to see institutional sponsorship increasing, as well. The higher the average dollar volume of the stock (liquidity), the better.
I want to see either tightness on the right hand side of the base or an EPS breakaway gap to trigger the breakout entry. If I miss the breakout entry, I will look to buy the first pullback or a shakeout of a weekly support level. I want to see volume increase above the average volume on the entry day.
These types of entries are important because they allow me to control my risk in case the trade doesn’t work out. I want all of those characteristics. However, I can overlook a lack of strong EPS growth if the sales growth is extremely strong and the stock is young. I can overlook a stock not trading within 25% of its all-time high if the stock is a young one coming out of its 1st accumulation phase in its history (LVGO in 2020 was an example) or a stock has its RS line very near a new high.
How you determine your stop loss for each trade?
One of my mentors taught me to determine my stop loss point BEFORE I determine my entry point on every trade so that is what I do.
My stop losses are almost always below the low of a daily bar formed in the last 1-3 days in all of my setups except for the EPS gap entry. I usually put my stop loss just below the close of a daily bar formed before the EPS gap entry. My entries are always within 10% of my stop loss price and usually within 7% of my stop loss price.
What are your sell rules?
I have 7 sell rules which trigger my exits (keeping my rules few and simple). They are the basic CANSLIM rules which come straight out of Bill’s books.
I do employ some discretion to the rules based on the performance of my stock, where the stock is positioned in the Weinstein/Wyckoff phase analysis, and the market environment. The weaker the stock’s performance, the later the stock is along its phase 2 or markup phase, and the weaker the market environment, the more likely I will do offensive selling which is my sell rule #3.
The stronger the stock’s performance, the earlier the stock is along its phase 2 or markup phase, and the stronger the market environment, the more likely I will do defensive selling using the 10 week MA (my sell rule #4) or offensive selling using the climax top sell rule to exit the stock.
Of course, these rules assume that other sell rules do not trigger first like falling 8% below my entry price, or reducing the position before an EPS report, or triggering a backstop.
Find more on this in a thread by Steve here:
How do you go from cash to fully invested with progressive exposure?
When I enter a position, my plan is to start out with 8 positions. How well my portfolio performs and the quality of the setups determine how quickly I buy these 8 positions. Over time, my goal is to reduce the number of positions to 5-6 by selling my weakest positions and force-feeding my strongest positions. I either build a full position by taking three 8% positions to create a 24% full position or take a 16% then 8% position to create a 24% position.
In a weak environment, I am slower in building a position. I generally will not buy the 2nd 8% position until I can raise my stop on the 1st 8% position to make it almost a breakeven trade.
In a strong market, I am much more willing to buy a 16% position at first and then not buy the 2nd 8% position until I can raise my stop on the 1st 16% position to make it an almost breakeven trade.
Ultimately, my goal is to make sure that the risk in a position in a stock does not exceed 1.5% of my equity. Also, I track my total portfolio risk by always knowing what my maximum drawdown will be if all of my stops are triggered in all of the stocks I own. This calculation gives me my worst case scenario. If the maximum drawdown is too much for my risk tolerance I will adjust my backstops.
What does post-trade analysis look like for you and what areas of your system has it helped you improve upon?
Post-trade analysis is critical for me. Post-trade analysis, along with studying the past TMLs, is how I came up with the rules I use now. The post-trade analysis was and still is a great way for me to identify my weaknesses and fix them.
These past 2 years, my post-trade analysis has helped remind me of concepts I had forgotten. For example, in 2021, my post-trade analysis showed me that my most profitable trades were EPS breakaway gaps. Unfortunately, I did not do very many of these trades. I know how powerful these trades can be but I failed to take full advantage of these trades in 2021. This post-trade analysis helped me to be more aggressive in taking the EPS breakaway gap trades in 2022 which helped me to have a profitable year. I am currently working on my 2022 annual post-trade analysis. This 2022 post-trade analysis has reminded me of the importance of not relaxing my stock selection criteria just so I can make a trade. My batting average in 2022 was a very poor 23%. The main reason for the low batting average was the bear market but part of the reason was my willingness to bend my stock selection rules which led to losing trades I could have avoided.
When I perform my annual post-trade analysis, I calculate:
My batting average, average gain and average loss
The “holy grail” formula - avg. gain % x % winning trades/avg. loss% x % losing trades = adjusted win/loss ratio which MUST equal at least 2:1 and really at least 3:1
My 2-3 biggest winners and 2-3 biggest losers
My equity curve, my market exposure throughout the year, my largest drawdown, and how long it took me to recover from my drawdown.
Also, I take a daily Nasdaq chart and plot on it where I made my initial buys on the stocks I purchased. This exercise is what led me to developing the WOO and also helps me to see how well or how poorly I took advantage of each WOO during the year. I categorize my trades by the buy setup to see which setup worked the best/worst for me. I categorize my exits by the sell rule to see how well my sell rules performed.
If I used any discretion in selling a stock, I want to see if the discretion increased or decreased my performance. I print out a daily/weekly chart of each stock showing the entries and exits. I keep a journal so I can go back and see the reasoning behind the entries/exits and what I was feeling, if anything at all, at the time.
Previous Trades
1. A well-handled winning trade - ARCH 0.00%↑
2. A mishandled losing trade - AMPH 0.00%↑
Learn more about CANSLIM from these great books written by William O'Neil:
Other related, relevant and helpful publications by Mark Minervini:
Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market
Think & Trade Like a Champion: The Secrets, Rules & Blunt Truths of a Stock Market Wizard
Would like to thank Steve for such an in-depth analysis and being so helpful throughout - there is so much valuable information in this post alone that could benefit traders!